5) Carry Trade
pg 74
1. The carry trade is the investment
strategy of going long in high-yield
target currencies and short in lowyield funding currencies.
The carry trade is one of the most
simple strategies for
currency trading that exists.
Carry Trade Fundamentals
The carry trade fundamentals.
The aim/ objective of the Carry Trade is to
profit from interest rate DIFFERENTIALS.
That is to borrow in one currency with a "low
yield" and invest in one or more "high yield"
currencies.
Typically the Japanese Yen- has been the
"funding currency of choice for "carry trade"
purposes.
"Mrs Watanabe"- The Kimono
Trader
Let's watch this short video.
http://jp.reuters.com/video/2011/03/30/japans-hedge-fund-housewives?videoId=199153009
I want you to think of a few questions using this
structure.
If I were the Interviewer I would have asked
her..............
If I were the interviewer I would
have asked..................
Third Conditional examples
(The third conditional talks about the past)
We talk about a condition in the past that did
not happen !
An example of the third conditional.
If I had won the lottery (last Saturday) I would
have bought a car.
If I were the Interviewer I'd have
asked............
EX: If I were the interviewer I'd have asked her
how much leverage she uses !
EX: If I were the interviewer I'd have asked her
which currency pair she dislikes.
Do you have any other comments on this ?
What are some adjectives you would use to
describe currency trading (retail in this case)
Carry Trade Fundamentals cont.
• Although the Carry Trade can result in large
gains through INTEREST RATE Differentials
and Currency Appreciation (and opportunities
for Arbitrage.)
• What is the underlying risk involved in Carry
Trade Activity. ?
If you said (or thought) Currency
Depreciation
you are CORRECT ! There is Currency Risk !
There is EXPOSURE to the high yielding
currency depreciating in value compared to
the "funding" or borrowed currency.
Right now, the US Dollar is the currency "in
vogue" for carry trade activity. There is a fear
that selling pressure will depreciate the dollars
value to even lower than it is today. (Law of S
and D)
Short and Long positions in FX
Think of the short position Yukiko san is in in
the video.
Definition of 'Short’ (or Short Position)
A trader is in a SHORT POSITION when
she sells a currency pair.
“Going Long” is the opposite of “going
short”. The trader is in a LONG POSITION
when she buys a CURRENCY PAIR.
The size of the FX Market
Tokyo’s spot currency market is
currently averaging about about $58bn
One analyst estimated such small
operators (with fewer than 15
employees) could account for as much
as 20-30 per cent of total FX trading
volume in Japan.
Let's look at a possible scenario:
Let's assume that the bond pays 4.5% and the Japanese interest
rate is set at 0%.
The trader stands to make a profit of
4.5% as long as the
_________________between the
countries does not change. Many
professional traders use this trade
because the gains can become very
large when _____________is taken
into consideration.
Short Selling
pg 72
Short selling is making money on a share even
when its price is falling.
This is not an easy concept to understand.
Please consider these two questions.
1. How can you sell something you don't own ?
2. What does "America's market regulator"
refer to ?
Short selling continued.
• Short selling is a bet AGAINST a company's
share price.
• The Investor (Speculator) expects the stock
price to go down.
• "Shorting" a stock is the opposite of buying a
stock which is often referred to as "going
long".
lead to unlimited losses because in theory share
prices can increase indefinitely.
• $ 300
• $ 100
•$0
A few more more points about short selling.
Most liquid stocks can be borrowed for a long time (for
the short-seller to keep short position)
Short-selling has a negative image almost everywhere
because it is linked to speculation.
Most countries with a developed financial market have
implemented short-selling bans since the summer of
2008.
The size of the Spot FX Market
Tokyo’s spot currency market is currently averaging about Y5,000bn —
or about $58bn per day
One analyst estimated such small operators
(with fewer than 15 employees) could
account for as much as 20-30 per cent of
total FX trading volume in Japan.
Some background on short selling
•In 1609, Mr. Le Maire, one of the key shareholders of the DEI Company sold
more shares in the company than he held.
•(meaning he borrowed shares off another counter-party)
He bet that the share price would fall with the
rise of a French competitor.
That assumption did not materialize. The
company’s share price rose back and Le Maire
was unable to buy back the shares to deliver
them.
26) Investment Banking
An Investment bank, simply put, is an intermediary
organization that uses its expertise and financial
knowledge to make possible for companies,
institutions and governments to take advantage of
business or investment opportunities
Let’s list the ones that you know. What else do you
know about them ? What happened to Lehman's
assets in Asia Pac. after they filed for chapter 11?
IB Divisions
Investment Banks usually operate a
number of different business divisions.
Sometimes these divisions are referred
to as “arms”.
Are you familiar with any of them ?
Argument against Investment Banks
Some people say these “Investment"
banks don't have nearly enough real
private capital to cover the bets on
derivatives they are underwriting.
whether it be swaps or options, futures
etc
These divisions usually include
1.RETAIL
2.GLOBAL MARKETS
3.INVESTMENT BANKING (Advising on M and A,
providing project finance etc)
4.ASSET MANAGEMENT
5.MERCHANT BANKING (focus on Private Equity)
What is the situation in Japan ? Are there similar
structures used ? What are the differences in IB
Structure if there are any ?
2) Universal Bank pg. 82
A universal bank participates in many
kinds of banking activities and is both a
commercial bank and an investment
bank.
UNIVERSAL BANKS AND THE GLASS
STEAGALL ACT (GSA)
The concept (of Universal Banks) is most relevant in the
UK and the US, where historically there was a legal
difference between pure investment banks and commercial
banks.
In the US, this was a result of the Glass
Stegall Act of 1933. In both countries,
however, the regulatory barrier to the
combination of investment banks and
commercial banks has largely been
removed (In the US through the GSA)
Recap: So what did the GSA do ?
The GSA prohibited banks from accepting
deposits and underwriting securities.
Everyone should understand that the GSA
made it ILLEGAL to combine Investment
and Commercial/Retail Banking.
Lets refer to the Financial crisis video.
GSA and GLB: Legal Framework in the
Financial Markets
If the GLB Act hadn’t repealed the GSA
then……………..
The GSA would have prevented the
Mortgage Lender from selling the mortgage
to the Investment Banker.
That may have prevented the crisis right
there. (As you know MBS were a product at the core of the GFC)
REVENUE MIX pg 86
So we have looked at the different divisions
Investment Banks operate.
Now, let us take a look at where they
receive their revenue from:
Please call them out as they are listed on
pg. 86
1. UNDERWRITING Revenues 2. Trading Income 3. Commission 4.
REPOS
BEHAVIOURAL ECONOMICS AND
FINANCE pg. 98
Behavioral finance is the study of the
influence of psychology on the behavior
of financial decision makers and the
subsequent effect on markets.
Why is it necessary (for some people)
to understand this field very well ?
EXCHANGES
pg. 108
AND OTC MARKETS
Definition:
Exchange: The place in which the trading of
goods, stocks, commodities, currencies or other
financial instruments occurs.
Lets have a look at the characteristics of each
Over-The-Counter Market -
A decentralized market of securities not listed on an
exchange where market participants trade over the
telephone, facsimile or electronic network mail/network
OTC markets are usually not regulated. There is
less Liquidity.
Examples of OTC markets include forex trading
markets, as well as markets for buying and selling
debt.
Over-the-counter markets have overtaken
exchange markets in terms of volumes traded
daily.
In exchange markets, there’s a regulator (The Exchange)
through which transactions are completed,
While in OTC markets there is no regulator.
Exchange markets have less chances of price
manipulation.
On the other hand competing traders in OTC markets can
manipulate prices. (key benchmarks)
Exchange markets ensure transaction security.
Historical Data is much easier to obtain on Exchange
traded products.
Sovereign Wealth Funds
pg 114
- SWF'
Pools of money derived from a country's reserves,
which are set aside for investment purposes
that will benefit the country's economy and
citizens.
The funding for a sovereign wealth
fund (SWF) comes from a central bank
reserves that accumulate as a result of budget and
trade surpluses。